Fundamentals/Principles of Transfer Pricing and substance in practice July 02, 2020 P V SRINIVASAN Corporate Advisor 1 WIRC of ICAI – Refresher Course on International Tax and Transfer Pricing
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Fundamentals/Principles of Transfer Pricing andsubstance in practice
July 02, 2020
P V SRINIVASANCorporate Advisor
1
WIRC of ICAI – Refresher Course on International Tax and Transfer Pricing
Why TP Functional & Economic Analysis
TP Overview
PART 1
Concept & Objectives
01Evolution
02Indian TP Regulations – an overview
• Applicability
• Associated Enterprise
• International Transactions
• Specified Domestic Transaction
03
Objectives of Transfer Pricing
Protection of tax base
No Discrimination between MNE group and independent enterprises
Equitable sharing of tax revenues between the nations i.e. the residence and source countries
Check avoidance of taxes under opportunities of tax arbitrage for domestic transactions
Let’s understand: Scenario 1
5
Company X
Company YThird Party Customer
India- tax rate 30%
Particulars India
Selling Price to 3Pcustomers in India
1,600
Selling cost of India 100
Cost of manufacture in Sgp 1,200
Total System Profits 300Singapore- tax rate 17%
Particulars Singapore India
Profit 100 200
Tax 17 60
Total tax 77
Tax cost (%) 25.6%
Sale of goods $1300
Cost $1200
Profit $100
Sale of goods $1600
Purchase of goods $1300
Cost $100
Profit $200
Let’s understand: Scenario 2
6
Company X
Company YThird Party Customer
India- tax rate 30%
Singapore- tax rate 17%
Particulars Singapore India
Profit 200 100
Tax 34 30
Total tax 64
Tax cost (%) 21.33%
Sale of goods $1400
Cost $1200
Profit $200
Sale of goods $1600
Purchase of goods $1400
Cost $100
Profit $100
Particulars India
Selling Price to 3Pcustomers in India
1,600
Selling cost of India 100
Cost of manufacture in Sgp 1,200
Total System Profits 300
Concept of Transfer Pricing (TP)
International transactions- goods- services- intangibles- loans
Independent entity
Taxpayer
Associated enterprise
Taxpayer
Transfer price Arm’s length price
1. “Arm's length price" means a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises, in uncontrolled conditions
2. Transfer Price or Transfer Pricing is not defined
7
Post 2001 scenario of Transfer Pricing in India
Finance Act 2001 introduced TP Regulations
• The Memorandum stated that:
“The increasing participation of multinational groups in economic activities in the country has given rise to new and
complex issues emerging from transactions entered into between two or more enterprises belonging to the same
multinational group. The profits derived by such enterprises carrying on business in India can be controlled by the
multinational group, by manipulating the prices charged and paid in such intra-group transactions, thereby, leading to
erosion of tax revenues. With a view to provide a statutory framework which can lead to computation of reasonable, fair
and equitable profits and tax in India, in the case of such multinational enterprises, new provisions are proposed to be
introduced in the Income Tax Act.”
• Section 92 in the Act was substituted by eight sections in the Income Tax Act numbered 92, 92A, 92B, 92C, 92CA, 92D, 92E and
92F - to curb tax avoidance by abuse of transfer pricing.
• Contents were explained in Explanatory Memorandum to the Finance Act, 2001
• Circular 14, 2001 was issued to familiarize the taxpayers falling under the Transfer Pricing provisions apart from the Act and
Rules
8
Indian Transfer Pricing RegulationsSections Provisions Relevant Rules
92 Computation of income having regard to ALP
92A Meaning of Associated Enterprise
92B Meaning of International transaction
92BA Meaning of specified domestic transactions
92C Computation of ALP Rule 10AB, 10B, 10C, 10CA
Other method, Determination of ALP, MAM, Range working
92CA Reference to Transfer Pricing Officer (TPO)
92CB Safe harbor rules Rule 10TA, 10TB, 10TC, 10TD, 10TE, 10TF, 10TG, 10TH, 10THA, 10THB, 10THC, 10THD,
92CC Advance Pricing agreement Rule 10F, 10G, 10H, 10I, 10J, 10K, 10L, 10M, 10MA, 10N, 10-O, 10P, 10Q, 10R,10RA, 10S, 10T
92CD Effect of advance pricing agreement
92CE Secondary Adjustment in certain cases Rule 10CB Computation of interest
92D TP documentation & Master File Rule 10D, 10DA List of information for TPD and MF
92E Accountant’s Report in Form 3CEB Rule 10E
92F Definitions Rule 10A Meaning of expressions for Rules 10AB to 10E
286 Country by Country reporting/ Intimations Rule 10DB9
Applicability
• The provisions of Section 92 to 92F of the Act are applicable only if:
• There are two or more enterprises (defined in Sec 92F); and
• The enterprises are AEs (defined in Sec 92A); and
• The enterprises enter into a transaction (defined in Sec 92F); and
• The transaction is an International transaction (defined in Sec 92B), includes deemed international transaction.
• Further w.e.f. 1 April 2012, TP provisions were extended to include specified domestic transactions (SDTs) also (defined
in Sec 92BA).
• Consequences of these provisions:
• Computation of income/ allowance of expenses having regard to the Arm’s length price [Section 92C]
• Maintenance of prescribed Documentation (Section 92D & Rule 10D)
• Obtaining of Accountant’s report (under Form 3CEB) (Section 92E) and filing the same within prescribed timeline
• To ensure compliance with the arm’s length principle, stiff penalties have been prescribed
10
Meaning of Associated Enterprises (Sec 92A)
Direct or indirect participation (through
one or more intermediaries) in
management or control or capital
A
C
B
A
C
B E
Both A and B are associated enterprises of C
D and E are also associated enterprises of C since they have a common ultimate parent (A)
D
11
Deemed Associated enterprises (Sec 92A(2))
1. >= 26% direct / indirectholding by enterprise
OR
2. By same person in eachenterprise
3. Loan >= 51% of Total Assets
4. Guarantees > = 10% of debt
5. > 10% interest in Firm / AOP / BOI
6. Appointment > 50% of Directors/oneor more ExecutiveDirector by anenterprise
OR
7. Appointment by sameperson in eachenterprise
8. Wholly dependent onuse of intangibles for manufacture / processing /business
9. Direct / indirectsupply of > = 90% Raw Materials under influencedprices and conditions
10. Sale under influenced prices and other conditions
11. One enterprise controlled by an individual and the other by himself or his relative or jointly
12. One enterprise controlled by HUF and the other by
- a member of HUF- his relative or - Jointly by member and
relative
Holding Management Activities Control
13. Any relationship of mutual interest between two enterprises, as may be prescribed.
12
International transaction (Sec 92B)
• Transactions between two or more AEs, either or both of whom are non-residents
• Transaction relates to:• Purchase, sale or lease of tangible or intangible property; or
• Provision of services; or
• Lending or borrowing money; or
• Any other transaction having a bearing on the profits, income, losses or assets of the enterprises; or
• Mutual agreements or arrangements for allocation or apportionment of, or any contribution to, any cost or expense incurred
As per Section 92F(V):
• “transaction” includes an arrangement, understanding or action in concert –• (A) whether or not such arrangement, understanding or action is formal or in writing: or
• (B) whether or not such arrangement, understanding or action is intended to be enforceable by legal proceeding.
13
Enhanced definition of International transaction (w.e.f. 1 April 2002)
• Purchase, Sale,
Transfer, Lease /
Use of
property/article/
product/ thing
• Includes Building,
Vehicle, machinery
etc.
• Purchase, Sale,
Transfer, Lease /
Use of IP
• Includes Transfer of
ownership/use of
rights/other
commercial right
Intangible PropertyTangible Property
International Transaction
• Long/short term
borrowing/ lending
• Guarantee
• Purchase/Sale
Securities
• Advances/
receivable,
Payments/any
debt etc.
Capital Financing
• Market Research/
Development
• Technical Service
• Scientific
Research
• Legal/Accounting
Service etc.
Provision of Services
• Transaction of
Business
restructuring/reorgani
zation with AE
irrespective of bearing
profit/income/loss or
assets – at the time of
transaction/future
date
Business Restructuring
14
CASE STUDY 1
Where an Indian company issues shares to its non-resident holding
company at premium, will provisions of TP be applicable?
Is there are a requirement to disclose such transaction in Form 3CEB?
15
CASE STUDY 2
If a non-resident company holding shares of an Indian company sells the shares to its
non-resident associated enterprise outside India, whether TP provisions would still
apply?
Whether the price charged for such transfer would have to be justified using ALP?
Whether both the companies would have to maintain documentation and also obtain
an accountant’s report?
16
Deemed international transaction- Sec 92B(2)
• For the purposes of this section and sections 92, 92C, 92D and 92E,
"international transaction" means a transaction between two or more
associated enterprises, either or both of whom are non-residents, in the
nature of purchase,………….. …………………………………
• A transaction entered into by an enterprise with a person other than an
associated enterprise shall, for the purposes of sub-section (1), be
deemed to be an international transaction entered into between two
associated enterprises, if there exists a prior agreement in relation to the
relevant transaction between such other person and the associated
enterprise, or the terms of the relevant transaction are determined in
substance between such other person and the associated enterprise
where the enterprise or the associated enterprise or both of them are
non-residents irrespective of whether such other person is a non-
resident or not.
A’s Parent 3rd party
A
Prior agreement
A’s Parent 3rd party
A
Determination of terms
CASE STUDY 3
• F Co (non-resident) has two subsidiaries in India (I Co1 and I Co2). Accordingly,
ICo1 and I Co2 are AEs.
• I Co1 propose to transfer one of its business undertakings to I Co2. There is an
understanding or arrangement which I Co1 has with F Co regarding transfer of
such business as well as the terms and conditions of transfer (including the
sale consideration).
• Is TP applicable to this transaction?
• Whether Section 92B(2) is applicable to transaction between I CO1 and ICo2?
18
CASE STUDY 4
• I Co (resident of India) is a distributor of goods in India.
• I Co enters into an arrangement with a third party contract
manufacturer in India for manufacture of goods and purchase.
• The terms and conditions of the agreement between I Co and third
party contract manufacturers are determined in substance by F Co, a
non-resident AE of I Co.
• Whether Section 92B(2) is applicable?
19
CASE STUDY 5
• F Co1 (non-resident) has a subsidiary I Co1 (resident) in India.
• F Co2 (non-resident) has a subsidiary I Co2 (resident) in India.
• F Co1 and F Co2 are different groups of MNCs and are not related.
• Pursuant to agreement between F Co1 and F Co2, one of business
divisions of F Co1 is agreed to be sold to F Co2 Group.
• Consequently, it is agreed that the parallel division in I Co1 also would
be sold to I Co2.
• Is 92B(2) applicable?
20
21
Residential status of the
Taxpayer
Residential status of the non
AE with whom the transaction
is being entered into
Residential status of the AE Applicability of section 92B(2)
to the transaction between
the Taxpayer and the non AE
which is being evaluated
Resident Resident Non-resident ?
Resident Non-resident Non-resident ?
Non-resident Resident Resident ?
Non-resident Non-resident Resident ?
Non-resident Resident Non-resident ?
Non-resident Non-resident Non-resident ?
Resident Resident Resident ?
Resident Non-resident Resident ?
Applicability of Section 92B(2)
22
Residential status of the
Taxpayer
Residential status of the non AE
with whom the transaction is
being entered into
Residential status of the AE Applicability of section
92B(2) to the transaction
between the Taxpayer and
the non AE which is being
evaluated
Resident Resident Non-resident YES
Resident Non-resident Non-resident YES
Non-resident Resident Resident YES
Non-resident Non-resident Resident YES
Non-resident Resident Non-resident YES
Non-resident Non-resident Non-resident YES
Resident Resident Resident NO
Resident Non-resident Resident NO
Applicability of Section 92B(2)
Applicability (contd.)
• Section 92(1)–
Any income arising from an international transaction shall be computed having regard to the arm’s length price.
Explanation - the allowance for any expense or interest arising from an international transaction shall also be
determined having regard to the arm’s length price
• Section 92(3) –
The provisions are not intended to be applied in case determination of arm’s length price reduces the income
chargeable to tax or increases the loss as the case may be
23
CASE STUDY 6
Where an Indian company issues shares to its non-resident holding
company at premium, will provisions of TP be applicable?
24
CASE STUDY 7
If an Indian company purchases a capital asset from its non-resident
associated enterprise, whether ALP will have to be justified for such
transaction (since, in such case, no deduction for expenses is claimed by
Indian company but only depreciation allowance would be claimed)?
25
CASE STUDY 8
US Co. provides some routine support services to I Co. US Co and I Co are
Associated Enterprises.
US Co. wants to know if the services should be charged to I Co. at cost or
at ALP (i.e. Cost-plus mark-up in the hands of US Co.)?
26
CASE STUDY 9
F Co and I Co and Associated Enterprises. F Co licenses royalty free
technology and manufacturing know-how to I Co. I Co commercially
exploits the technology and know-how in the Indian market.
Please advice your client on the TP implications.
27
SB decision in the case of Instrumentarium Corporation Limited
• Instrumentarium Corporation Limited (Instrumentarium or the taxpayer), a company
incorporated in Finland had advanced an interest free loan to its wholly owned subsidiary in
India (Indian AE).
• The tax authorities made TP adjustment by determining arm’s length interest on the loan.
• The taxpayer’s argument
• Relied on base erosion principles - section 92(3) of the Income Tax Act, 1961 (the Act);
Circular Nos. 12 and 14 of 2001 issued by the Central Board of Direct Taxes (CBDT),
• Arm’s length interest charge would lead to erosion of tax base in India (tax benefit of
34% on interest expense deduction for the Indian AE vis-à-vis 10% taxation on interest
income for tax payer)
• Advancing interest free loan is shareholder's activity
• TP provisions should not apply in the absence of income arising in the first place
• ITAT Special Bench ruled against the tax payer
India
Finland
Provision of interest free loan to its wholly owned subsidiary
Indian Associated Enterprise (AE)
Instrumentarium Corporation
28
Key observations of the SB
• Rejected taxpayer’s reliance on base erosion principles:
• As per section 92(3), the impact of profits or losses needs to be seen for the year under consideration and qua the taxpayer
only.
• In the absence of correlative relief, addition made to income of the non-resident taxpayer would not be available as a deduction
to its Indian AE
• “Base erosion theory” cannot be applied by merely comparing the nominal tax rates at which the income recipient and payer of
the income are taxed.
• Cannot overlook the “tax shield” which is available to the taxpayer (in the facts of the case the Indian AE had carry-over losses;).
• Role of ‘intent of legislature’ comes into play only when there is any ambiguity in the words of the statute. Since, there was no
ambiguity in the provisions of section 92(3), the intent of introducing transfer pricing provisions was not relevant.
• Argument of shareholder’s was not upheld as in the facts of the case, the tax payer had been paying interest during earlier years
when profitable
• Zero interest is not “no income” – there is a charge applicable and hence, section 92(1) being computational provisions shall be
applicable.
29
Specified Domestic Transaction – Sec 92BA
• Scope of TP provisions expended w.e.f AY 2013-14 by including “SDT” if aggregate value of such transactionexceeds INR 50 Million ( 5 Crores) – Finance Act 2012; Threshold increased to INR 20 crores w.e.f AY 2016-17 – Finance Act 2015
• Applicability of TP regulations (including procedural and penalty provisions) to specified transactionsbetween domestic related parties and payments made to related parties.
• All provisions applicable for determination of ALP for international transactions would apply in case of SDTalso. Also penal provisions applicable to international transactions would apply to SDT
30
Specified Domestic Transaction – Sec 92BA • “Specified Domestic Transactions “ in case of an assessee means any of the following transactions , not
being an international transaction , namely -
• Any expenditure in respect of which payment is made or to be made to a person u/s 40A(2)(b) ;
• Any transaction referred u/s 80A ;
• Any transfer of goods/services u/s 80-IA (8);
• Any business transaction u/s 80-IA(10) ;
• Any transaction under Chapter VI-A or u/s 10AA – to which provisions of Sec 80-IA (8) or (10) applies ;
• Any business transaction between the persons referred to in sub-section (6) of section 115BAB* ;
• Any other transaction as may be prescribed.
• Omission of applicability of SDT to persons referred to in section 40A(2) w.e.f. AY 2017-18 – Finance Act2017
• Had the impact of coverage of remuneration to Key Managerial Personnel !!!
* Section 115BAB(6) – New manufacturing domestic company and any other person
31
PART 2
32
Transfer Pricing Documentation
Accountants Report
Master File and CbC Reporting
Domestic Litigation
Safe Harbour
Advance Pricing Mechanism
Mutual Agreement Procedure
Secondary adjustments
Limitation on interest deduction
Penalties
• Detailed documentation not required in case aggregate transaction value is less than Rs. 1 Crore
• Detailed documentation is required to be maintained in case the aggregate value of specified domestic transactions exceeds
INR 20 crores
• Contemporaneous data requirements
• Documentation to be maintained as of the specified date – One month prior to the due date for furnishing the return of
income under sub-section (1) of section 139 for the relevant assessment year
33
Transfer Pricing Documentation
Transfer Pricing DocumentationA detailed list of mandatory documents are given in Rule 10D(1) of the Rules.
• Ownership Structure• Profile of multinational group• Business description/ Profile of industry• Nature and terms (including price) of international transactions• Description of functions performed, risk assumed and assets
employed(functional analysis) • Records of economic and market analysis (economic analysis) • Record of budgets, forecasts, financial estimates• Any other record of analysis (if, any) to evaluate comparability of
international transaction with uncontrolled transaction(s)• Description of method considered with reasons of rejection of other
methods• Details of transfer pricing adjustment(s) made (if any)• Any other information e.g. data, documents like invoices, agreements, price
related correspondence etc.
Entity Related
Price Related
Transaction Related
34
• Obtained by every tax payer filing a return in India and having international transaction or SDT
• To be filed by due date for filing return of income
• Essentially comments on the following:
• whether the tax payer has maintained the transfer pricing documentation as required by the legislation,
• whether as per the transfer pricing documentation the prices of international transactions are at arm’s
length, and
• certifies the value of the international transactions as per the books of account and as per the transfer
pricing documentation are “true and correct”
35
Accountant’s report (Form 3CEB) - Rule 10E
TP documentation framework in India
CBC REPORT
• Who has to file CbC report in India? Parent entity resident in India
• Alternate reporting entity (ARE) if it is resident in India
• Indian affiliate of an MNC group, in certain exceptional cases
• Indian affiliate to notify tax authority on parent entity/ARE that would be filing the CbC report on behalf of the Group
MASTER FILE
• Indian affiliates of an international group to maintain prescribed information if specified threshold is exceeded
• Rules introduced to prescribe additional information/ documents in line with Action 13
LOCAL FILE
• Current Indian TP rules prescribe maintenance of contemporaneous TP documentation
• Includes information about the local business, including details on intercompany transactions
TP Documentation: Section 92D(1)(i)/Rule 10D
Enterprise Centric documents Transaction Specific Documents Computation and connected Documents
Ownership details [10D(1)(a)] Terms of International Transaction [10D(1)(d)]
Analysis of methods used for determining ALP [10D(1)(i)]
Profile of the multinational group [10D(1)(b)]
FAR Analysis (Functions, Assets and Risks Analysis) [10D(1)(e)]
Workings for determining ALP [10D(1)(j)]
Business profile of taxpayer and AE [10D(1)(c)]
Economic and Market Analysis [10D(1)(f)] Assumptions, policies and Price Negotiations [10D(1)(k)]
Record of Uncontrolled Transactions [10D(1)(g)]
Adjustment details [10D(1)(l)]
Evaluation of comparability [10D(1)(h)] Any other information [10D(1)(m)]
• Contemporaneous documentation requirement – Rule 10D• Documentation to be kept and maintained for 8 years from the end of the relevant assessment year.• No specific documentation requirement if the value of the international transaction is less than one crore rupees.
LOCAL FILE BEPS ACTION 13 vs. INDIA Rule 10D DOCUMENTATION
RULE 10D DOCUMENTS
LOCAL FILE
• Group overview and Ownership structure
• Business and industry overview
• Selection of most appropriate TP method
• Description of controlled transactions
• Functional analysis
• Comparable transactions or companies
• Economic analysis
• Supporting documents
• Organizational structure
• Detailed business strategy
• Competitors
• Controlled transactions
• Intercompany payments and receipts
• Associated enterprises
• Intercompany agreements
• Detailed comparability and functional analysis
• TP method selected
• Tested party
• Assumptions applying TP method
• Explanation of multiyear analysis
• Comparable transactions or companies search and financials
• Comparability adjustments
• Conclusions
• TP method financial information
• Copy of APAs and tax rulings
Master File Requirements: Section 92D(1)(ii)/Rule 10DA
Entity responsible Filing obligation Threshold for applicability Due date
Constituent entity
(CE)
Master file to be filed in Form
3CEAA
Part A of Form 3CEAA — General
information for all constituent
entities
Part B of Form 3CEAA —
Consolidated group revenue of INR
500 crore
and
(i) Aggregate value of international
transaction exceeds INR 50 crore
or
(ii)Value of purchase, sale, transfer
etc. of intangible property
exceeds INR 10 crore
Form 3CEAA
Filing of the return of
income as per section
139 (1) of the Act.
Form 3CEAB
30 days before the due
date for filing Form
3CEAA
Designated CE
Notification report to be filed to
designate a CE in Form 3CEAB
and
Master file to be filed in Form
3CEAA
Contents Of Master File
Organization structure
Structure chart:
• List of all the operating entities along with their addresses
• Legal status and ownership
Business description
• Nature of business
• Important drivers of business profit
• Supply chain of:
• Five largest products/services by turnover
• Products/services generating more than 5% of group sales
• Main geographic markets for the products/services
• Description of important service arrangements along with their capabilities
• Functional analysis of the entities that contribute at least 10% of the revenue, asset and profit of the MNE group
• TP policy for service cost allocation and pricing intra-group services
• Business restructuring/acquisitions/divestments during the financial year
Intangibles
• Overall strategy description
• List of entities (with address) engaged in development and management of intangibles
• List of important intangibles and legal owners
• List of important intangible/cost contribution/research/license agreements
• TP policy for R&D and intangible
• Details of important transfers
Intercompany financial activities
• Financing arrangements of the group, including names and address of top 10 unrelated lenders
• List of entities providing central financing functions with address of operation and effective management
• Details of financial TPpolicies
Financial and tax positions
• Annual consolidated financial statements
• List and description of existing unilateral advance pricing agreements (APAs) and other tax rulings
Note: Departure/ additional information vis-à-vis BEPS Action 13 requirement
Master File information and risk assessment
• A master file provides the tax administrations with high-level information on the global business operations
and TP policies of an MNE.
• The master file differs from typical current documentation standards as it has a global scope and should
provide an overview of the global value chain.
• Possible use of master file information during audits by tax authorities
▪ Supply chain: Re-invoicing companies
▪ Service arrangements: Place of effective management (PoEM)
▪ Geographic markets: Main markets and General Anti-Avoidance Rules (GAAR) type legislation
▪ Business restructuring: Exit tax
▪ FAR analysis: Action 9 and contractual allocation of risk
▪ List of entities engaged in development and management of intangibles: Return based on function
▪ List of agreement on intangibles: Cost contribution arrangements (CCA)/Royalty payment
▪ TP policy on intangibles: R&D policy and R&D credits
▪ Intercompany financial arrangement and treasury function: Profits belong to entity undertaking decisions
Section 286 – CbC Reporting and applicability
• Who has to file CbC report in India?
• Parent entity resident in India
• Alternate reporting entity (ARE) if it is resident in India
• Indian affiliate of an MNC group, in certain exceptional cases
• Indian affiliate to notify tax authority on parent entity/ARE that would be filing the CbC report on behalf of the Group
• Applicability - Total consolidated group revenue as reflected in the consolidated financial statements for the preceding accounting year exceeds INR 5,500 crores.
• Where the consolidated revenue is reflected in foreign currency, the exchange rate shall be the TT buying rate of such currency on the last day of the preceding the accounting year.
• Information in the CbC Report shall include:
• Amount of revenue, profit or loss before income-tax, income-tax paid, income-tax accrued, stated capital,accumulated earnings, number of employees and tangible assets (other than cash or cash equivalents), for eachcountry or territory
• Details of each constituent entity
• Nature and details of the main business activity or activities of each constituent entity; and
• any other information as may be prescribed
SECTION 286 – CbC Reporting and applicability
• Exceptional cases requiring CbC filing by CE [Section 286(4)]• Parent entity not obliged to file the Cbc report; or• India does not have an agreement providing for exchange of the report; or• There is a systemic failure and the said failure has been intimated by the prescribed authority to such CE.
• Exceptional cases requiring CE filing (above) does not apply if ARE has furnished the CbC report and the followingconditions are satisfied, namely:—• the report is required to be furnished under the law for the time being in force in the said country or
territory;• the said country or territory has entered into an agreement with India providing for exchange of the said
report;• the prescribed authority has not conveyed any systemic failure in respect of the said country or territory to
any constituent entity of the group that is resident in India;• the said country or territory has been informed in writing by the CE that it is the alternate reporting entity
on behalf of the international group; and• Appropriate intimations made to the Indian prescribed authority.
• Following terms defined – (i) Accounting year; (ii) Agreement; (iii) Alternate Reporting Entity; (iv) Constituent Entity; (v) Group; (vi) Consolidated Financial Statements; (vii) International Group; (viii) Parent Entity; (ix) Permanent Establishment; (x) Reporting Accounting Year; (xi) Reporting Entity; (xii) Systemic failure
CBC Reporting/ Compliance Obligations
S.No Filing obligation Contents of the Form Accounting periodDue date
(As per current Rules)
1. Form 3CEAC
Intimate
(i) it is ARE; or
(Ii) details of Parent or ARE
Applicable accounting year for financial
statements
2 months prior to due date for filing
Form 3CEAD
2. Form 3CEAD CbC ReportingApplicable accounting year for financial
statements
12 months from the end of the relevant
reporting accounting year*
3. Form 3CEAENotify details of designated entity
in IndiaNA No due date specified
- * In case of systemic failure, shall be reduced by 6 months from the end of the month in which said systemic failure has been intimated
FORM 3CEAD – CbC report
• Ultimate Parent Company, being
resident in India
• CE, being resident in India,
designated as the ARE
• Conditions in S-286(4) triggered and
no ARE is designated.
FORM 3CEAC - Intimation
• CE, being resident in India, designated as the
ARE
• CE, being resident in India, Parent is not
resident in India
• S-286(4) conditions not triggered
• S-286(4) conditions triggered but
Group has designated another ARE
[which satisfies S-286(5)]
FORM 3CEAE - Designation
• Conditions in S-286(4)
triggered; no ARE is designated
and there are more than one
CE in India
Form 3CEAD – Country-by-Country Report
Tax Jurisdiction
RevenuesProfit (loss)
Before
Income Tax
Income Tax
Paid (on cash
basis)
Income Tax Accrued –
Reportable Accounting
Year
Stated capital
Accumulated earnings
Number of
Employees
Tangible Assets
other than Cash and
Cash Equivalents
Unrelated
party
Related
partyTotal
1.
2.
3.
4.5.
6.
7.
Etc …
Table 1. Overview of allocation of income, taxes and business activities by tax jurisdiction
Tax Jurisdiction
Constituent Entities
resident in the Tax
Jurisdiction
Tax Jurisdiction of organization
or incorporation if different from
Tax Jurisdiction of Residence
Main business activity(ies)
Re
sear
ch &
Dev
elo
pm
en
t
Ho
ldin
g o
r
man
agin
g IP
Pu
rch
asin
g o
r
Pro
cure
me
nt
Mfg
or
pro
du
ctio
n
Sale
s, m
arke
tin
g
or
dis
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2.
3.
1.
2.
3.Etc …
• Specify nature of the activity in the ‘Additional Information’ section, if ‘Other’ is chosen
• Table 3 (Additional Information) requires to include any further information or explanation that is considered necessary or that would facilitate the understanding of the compulsory information provided in the CBCR
Table 2. List of all the Constituent Entities of the MNE group included in each aggregation per tax jurisdiction
Form 3CEAD – Country-by-Country Report
Use of CbC - CBDT Instructions
• On 27th June, 2018 vide Instruction No.2/2018, CBDT provided guidance on appropriate use of CbC Reports
• Access to CBC Reports:
• All CbC Reports shall be primarily accessed by Competent Authority of India and DGRA.
• In case where any CE is selected for scrutiny, the jurisdictional TPO will have access .
• To safeguard use of information, standard operating procedure will be formulated by CRAU of DGRA.
• Appropriate Use of the CbC Reports:
• TPO can use the CbC Reports information primarily for the following three purposes:
• High Level TP risks assessment – In case CbC Report indicates any potential risks on TP arrangement, thereports may be used for planning a tax audit of Indian taxpayer for relevant assessment year.
• Assessment of other BEPS related risks – Detailed enquiry to be conducted during assessment toexamine possible tax risks unrelated to TP .
• Economic and Statistical Analysis – CbC reports may be used for economic and statistical Analysis, interms of understanding its use, identifying features , use and risk of the report and tax system , inconsistency with provisions of tax treaties.
Use of CbC - CBDT Instructions
• Inappropriate Use of CbC Reports – Use of CbC Report will be considered inappropriate in following two situations:
• If information is used as a substitute for a detailed TP analysis of international transactions and determination of arm’slength price based on a detailed functional and comparability analysis; and
• If the information is used as the only evidence to propose a TP adjustment
• Confidentiality of the CbC Reports –
• Any report received through exchange of information or under Section 286(2) or 286(4) are subject to requirement of taxtreaties.
• Hence, all the officers who handle the reports are directed to strictly follow the detailed guidelines on maintainingconfidentiality in Chapter VII of Manual on Exchange of Information.
• Monitoring, control and review
• Use of CbC Report information by the TPO shall be monitored by jurisdictional CIT(TP) and breach be informed toCompetent Authority.
• Any concern raised by taxpayer on inappropriate use of information, shall be reported by TPO to jurisdictional CIT(TP).
• Adjustment made based on inappropriate use to be conceded by Competent Authority of India.
• Use of information shall be regularly reviewed by CBDT through Competent Authority of India.
BEPS Action 13 in Indian context
• Finance Act, 2016 amended the Income-tax Act, 1961 (‘the Act’) to introduce provisions for additional TP
documentation and CbC reporting. To be applicable w.e.f. 1 April 2017.
• Section 92D amended to provide for :
• the keeping and maintaining of the master file by every constituent entity (‘CE’) of an international group
• CE to furnish the above information and documents to the prescribed authority (under new section 286) in
the prescribed forms; Amendment vide Finance Act 2019.
• New Section 286 introduced to cast CbC reporting and furnishing requirements on Parent entity/ Alternate
Reporting Entity/ Constituent Entity (CE)
• CBDT notified the final Rules for CbC report and master file on 31 October 2017
• These are largely in line with the OECD’s final report on Action 13, with minor deviations
49
BEPS Action 13 – An overview
• Action 13 is designed to increasetransparency by providing tax authoritieswith sufficient information to allow them toconduct transfer pricing risk assessmentsand consider whether groups have engagedin BEPS-type activities.
• It requires companies to use a consistentthree-tier framework for providinginformation on global allocation of income,economic activity and intercompany pricingacross all of a company’s global operations.
• CbC reporting applies to multinationalenterprises.
Master file
High-level information about theMNE’s business, transfer pricingpolicies and agreements with taxauthorities in a single documentavailable to all tax authorities wherethe MNE has operations
Local file
Detailed information about the localbusiness, includingrelated-party payments and receiptsfor products, services, royalties,interest, etc.
CbC report
High-level informationabout thejurisdictionalallocation of profits,revenues, employeesand assets
50
Litigation process – an overview
AO / TPO
(2-3 years)
CIT(A)/ DRP
(1-2 years)
Tribunal
(2-3 years)
Jurisdictional High Court
(3-4 years)
Supreme Court of India
(4-5 years)
12 to 16 years
*If the case is remanded, then the over-all time limit may increase accordingly
• Appeal by either party in case of favorable resolution at lower level
• Build up of cases at Tribunal level; factual nature of issues results in being remanded
Audit adjustments create cash flow issues
Time consuming and several tiers of appellate authorities
Domestic tax lawappeal process
• Requirement to pay entire tax demand, unless stay is obtained
• Use of coercive action to enforce tax collection
Alternate Dispute Resolution Mechanism – (i) Safe Harbour; (ii) Advance Pricing Agreement, (iii) Mutual Agreement Procedure
51
• Safe Harbour – Defined as circumstances in which Tax Authorities shall accept the transfer price or income
deemed to accrue or arise u/s 9(1)(i), as the case may be, declared by the Taxpayer
• Safe harbour applicable to international transactions at the option of the Taxpayer or income referred to in
section 9(1)(i), i.e., through or from any business connection in India, property in India, asset or source of income
in India or through the transfer of a capital asset situated in India.
• Ineligible taxpayers - International transaction with AE located in;
• Country or territory notified under section 94A or
• No tax or low tax country or territory i.e. income tax rate less than 15%
52
Indian Safe Harbor Rules
• Taxpayers can opt to apply safe harbour rules inter-alia for the following international transactions:
a) Provision of software development services / ITeS / Knowledge Process Outsourcing (KPO) services with insignificant risk
b) Provision of contract R&D services relating to IT / generic pharmaceutical drugs with insignificant risk
c) Intra group loan to non-resident wholly owned subsidiaries
d) Provision of explicit corporate guarantee to loans taken by non-resident wholly owned subsidiaries
e) Manufacture and export of core and non-core auto components where at least 90% of sale is to OEM
f) Receipt of intra-group low value added services
• First set of Rules applied to AY 2013-14 and four AYs immediately following it
• Amended Rules applicable from AY 2017-18 and two AYs immediately following it.
• Also applicable to certain specified domestic transactions
• Budget Amendment: the Provisions of Safe Harbor Rules and Advance Pricing Agreement shall now apply also for
determination of income attributable to the operations carried out in India by a non-resident.
53
Indian Safe Harbor Rules
Advance Pricing Agreement (APA)
• CBDT empowered, with effect from 1.07.2012 to enter into APA with any person in relation to an international
transaction for determining ALP or specifying the manner of determining income referred to in section 9(1)(i)
• As per method referred in S. 92C or the method provided by rules made under this Act
• With such adjustments or variations as may be necessary/expedient
• The agreement shall be valid for period not exceeding five consecutive previous years; Roll back permissible for
4 prior years.
• APA is binding on the concerned person and the tax authorities provided there is no change in law or no change
in facts
• With approval of Central Government, APA can be regarded as void ab initio (as if the agreement was never
entered into) if obtained by fraud or misrepresentation of facts
• CBDT given the powers to prescribe a scheme specifying the manner, form, procedure and any other matters in
respect of APA [Rule 10F to Rule 10T]
• Taxpayer to furnish modified return, limited to the impact of APA, within 3 months of date of APA, including for
years for which assessments have been completed.
• Taxpayer may be disentitled to claim the impact of APA in the event of delay in submission of modified return
54
Mutual Agreement Procedure - An Overview
• MAP is an alternate mechanism incorporated into tax treaties for the resolution of international tax disputes
• MAP and domestic tax law appeals are mutually exclusive. MAP is therefore an alternative to or in addition
to the domestic tax law appeal process
• Scope limited to issues pertaining to tax treaties (including TP) and does not extend to domestic tax laws
• Resolution of disputes through intervention of Competent Authorities (CAs) of each state who evolve a mutually
acceptable solution
• Possibility of dispute resolution through a negotiated settlement
• Relief through MAP possible regardless of remedies available under domestic tax laws
• Issues which can be resolved through MAP
• Disputes where taxpayer contends that he is being taxed in a manner not in accordance with the tax treaty
• Issues relating to interpretation of terms appearing in the tax treaty
• Elimination of double taxation in cases not covered by tax treaties
55
Mutual Agreement Procedure - An Overview
• Article 9(2) of the OECD Model Tax Convention prescribes corresponding adjustment for transfer disputes and
use of MAP process for the same.
• The Indian Government had previously denied access to MAPs for TP disputes and bilateral APAs(BAPAs) in the
absence of Article 9(2) in the tax treaty, resulting in no access to MAPs for TP disputes and BAPAs to taxpayers
located in some of India’s larger trading partner companies, such as France, Germany and Italy.
• A press release was issued on 27 November 2017 by the Indian Government, allowing, for the first time, MAPs
for TP disputes and bilateral APAs with Germany, France and Italy, among other countries.
• Multilateral Instrument (MLI) clarifies this position as minimum standard in tax treaties
56
SECONDARY ADJUSTMENTS w.e.f 1 April 2018 [FA 2017]
57
Secondary Adjustments
• Adjustment in the books ofaccounts of the Assessee and itsAE:
• to reflect that actual allocationof profits between the Assesseeand its AE are consistent withthe transfer price determined asa result of primary adjustment
• thereby removing the imbalancebetween cash account and actualprofit of the Assessee
Scenarios
• Where a primary adjustment in TP ismade in excess of INR 1 crore in thehands of an Indian taxpayer, in any ofthe following situations:
• suo-moto by the taxpayer in thereturn of income
• by the AO in assessment andaccepted by the taxpayer
• APA
• Safe Harbor Rules
• MAP settlement.
• Under any of the above situations,the excess money available with theAE would need to be repatriated toIndia by the AE within a time limit tobe duly prescribed
• Not applicable to Primary adjustmentmade in respect of AY 2016-17 orbefore
Consequences of non-repatriation of funds by AE
• Such funds would be deemed to be an advance made by the taxpayer to such foreign AE
• The interest thereon shall be computed in a manner to prescribed [Rule 10CB]
• Such interest will be taxed in the hands of the taxpayer
• FA 2019 Amendments:
• Excess money may be repatriated by any AE
• Where excess money not repatriated, additional income tax at 18% may be paid
THIN CAPITALISATION
Applicability
• An Indian company or a PE of a foreign company being the borrower who pays interest exceeding INR 1 crore in respect of any debt issued or guaranteed by a non-resident AE
• Also covers
• Implicit/explicit guarantee provided by AE in relation to third party loans; or
• AE depositing a corresponding and matching amount of funds with the third party lender
• Not Applicable for Assessee engaged in banking/insurance business
Allowability
• Interest expenses to be allowed as deduction, shall be lower of the following:
• 30% of its earnings before interest, taxes, depreciation and amortization (EBITDA); or
• interest paid/ payable to AE
• Allows for carry forward of disallowed interest for a period of 8 AYs immediately succeeding relevant AY
58
Budget Amendment – Sub-section (1A) u/s 94B inserted so as to provide that provisions of interest limitationswould not apply to interest paid in respect of debt issued by a lender which is a PE in India of a non-residentengaged in the business of banking. [Effective from April 1, 2021]
TP Penalties-Section 271Default Penalty
Furnishing of incorrect information in any report or
certificate furnished by an accountant or a
merchant banker or a registered valuer→ u/s 271J
Rs. 10,000 for each report or certificate to be paid by the
issuer of certificate
Post-inquiry adjustment (deemed concealment of income) → u/s 270A*
►No penalty, where transfer pricing documentation
maintained, transaction declared and material facts
disclosed
►Penalty at 50% of tax on transfer pricing adjustment, where
transfer pricing documentation not maintained
►Penalty at 200% of tax on transfer pricing adjustment, where
the TP adjustment is in consequence of not reporting an
international transaction.
*Amended as notified by Finance Act 2016, w.e.f from 1 April, 201759
TP Penalties-Section 271
Default Penalty
Failure to maintain information or documents / Fails to report transactions / Maintains or furnishes an incorrect information or documents → u/s 271AA
2% of the transaction value
Failure to furnish information or documents → u/s 271G
2% of the transaction value
Failure to furnish accountants report → u/s 271BA Rs 100,000
60
Consequences of non-compliance
61
Particulars Penalties
Not maintaining and filing the required information in the master file within the due date
INR500,000
Non-filing of CbC report by Indian resident parent company/ARE
• INR5,000 per day up to one month
• INR15,000 per day beyond one month
• INR50,000 per day for continuing default after service of notice
Not furnishing the information called for by the tax authority within the given time limit
• INR5,000 for every day up to the service of the penalty order
• INR50,000 per day for the default beyond the date of service of the penalty order
Furnishing inaccurate particulars/not filing the corrected CbC report within 15 days
INR500,000
PART 3- Function, Asset and Risk Analysis
62
Relevant provisions /guidance on FAR analysis
63
Income-taxAct, 1961
• Section 92C(1) of the Income Tax Act, 1961 read with Rule 10B(2) and Rule 10C(2) of the Income Tax Rules, 1962, requires comparability of FAR analysis to determine ALP.
• Rule 10D(1)(e) requires FAR analysis to be a part of statutory TP documentation
OECDTP Guidelines
• Para D.1.2 provides for the TP documentation to be based on a detailed functional analysis
UN Practical Manualon TP for DevelopingCountries
• Para B.2.3.1 - Understanding the Economically Significant Characteristics of the Industry, Business and Controlled Transactions provides for a detailed discussion on the FAR analysis, including a detailed FAR checklist [Part 3 of Appendix 1 to the UN TP Manual]
ICAI Guidance Note on TP report u/s. 92E
• Para 7.33 of the Guidance Note describes the FAR analysis stipulated under Rule 10D(1)(e) as part of TP documentation.
Rule 10B(2) For the purposes of sub-rule (1), the comparability of an international transaction [or a specified domestic transaction] with anuncontrolled transaction shall be judged with reference to the following, namely:—
(a) the specific characteristics of the property transferred or services provided in either transaction;(b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respectiveparties to the transactions;(c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly orimplicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions;(d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographicallocation and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overalleconomic development and level of competition and whether the markets are wholesale or retail.
(3) An uncontrolled transaction shall be comparable to an international transaction [or a specified domestic transaction] if—
(i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into suchtransactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in theopen market; or(ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences.
64
Determination of ALP – Rule 10B(4) & Rule 10B(5)
Data to be used for undertaking comparability analysis
1. If MAM is RPM, CPM or TNMM
• the data relating to the current year; or
• If the data relating to the current year is not available; then use the data relating to FY immediately preceding the current FY
Data relating to the current year subsequently available during the course of any assessment proceeding shall be used irrespective of the fact that the data was not available at the time of preparation of TP documentation
2. If MAM is CUP, PSM or Other method
• Use only data relating to current year
Rule 10C
(2) In selecting the most appropriate method as specified in sub-rule (1), the following factors shall be taken intoaccount, namely:—
(a) the nature and class of the international transaction [or the specified domestic transaction];
(b) the class or classes of associated enterprises entering into the transaction and the functions performed bythem taking into account assets employed or to be employed and risks assumed by such enterprises;
(c) the availability, coverage and reliability of data necessary for application of the method;
(d) the degree of comparability existing between the international transaction [or the specified domestictransaction] and the uncontrolled transaction and between the enterprises entering into such transactions;
(e) the extent to which reliable and accurate adjustments can be made to account for differences, if any, betweenthe international transaction [or the specified domestic transaction] and the comparable uncontrolledtransaction or between the enterprises entering into such transactions;
(f) the nature, extent and reliability of assumptions required to be made in application of a method.
66
Computation of ALP – Rule 10CA
Concept of range
1. If MAM is CUP, RPM, CPM or TNMM and there are at least 6 comparables
• Prepare a dataset in ascending order
• Arm’s length range would be data points lying between the 35th and 65th percentile of the data set.
• If the transaction price falls within the range, then the same shall be deemed to be the ALP.
• If the transaction price falls outside the range, the ALP shall be taken to be the Median of the data set.
2. In all other cases, arithmetic mean shall be applied. Tolerance range of 1% or 3% (as the case maybe) be applied from transfer price.
3. Where multiple year comparable data is available, weighted average of such data shall be taken based on prescribed weights.
Broad based Analysis
• Review of Controlled transaction
• Company Overview
• Group Overview
• Industry Overview
Principles in Comparability
• FAR Analysis
• Characterization
• Tested Party
• Transfer Pricing Methods
• Profit Level Indicators
• Contemporaneous Data
Comparability - Approach
• Identification of databases
• Selection of potential comparables
• Comparability Adjustments
• Price setting vs. Price testing
Key aspects in TP analysis
68
Most appropriate method – An overview
69
“No one method is suitable in every possible situation, nor is it necessary to prove that a particular method is not suitable under the circumstances.”
Para 2.2 OECD TP Guidelines for Multinational Enterprises and Tax Administrations
Appropriateness of the method considered based on functional analysis
Availability of reliable information
Reliability of comparability adjustments, if any
Degree of comparability between controlled and uncontrolled transaction
Transfer Pricing Methods
70
01Comparable Uncontrolled Price Method (CUP)
02Resale Price Method (RPM)
03Cost Plus Method(CPM)
04Profit Split Method(PSM)
05Transactional Net Margin Method (TNMM)
06Any Other Method
Transfer Pricing Methods.. A comparison
MethodMeasurement
focusComparability Requirements
Indicative difference requiring adjustments
CUP Price • Similar products• Similar conditions
• Product quality• Contractual terms• Level of market• Intangible property • Transaction date• Foreign exchange
RPM Gross Income
• Similar functions • Risk • Contractual terms• Similar product group
• Inventory levels• Turnover rates• Operating expenses• Foreign currency risks• Accounting differences
71
Transfer Pricing Methods.. A comparison
Method Measurement focus Comparability RequirementsIndicative difference requiring
adjustments
CPM Gross Income
• Similar functions • Risk • Contractual terms• Similar product group
• Operating complexity• Operating expenses• Foreign currency risks• Accounting differences
TNMMNet Operating
Income
• Functions • Assets • Risks
• Economic risk adjustment• Foreign currency risks• Accounting differences
PSM Profit
• Functions performed – routine and non-routine
• Value drivers • Industry value indicators• Multiple transactions
72
Typical Business Models
73
• Toll Manufacturer• Contract Manufacturer• Licensed Manufacturer• Full fledged Manufacturer
Manufacturer
• Captive Service Provider• Limited Risk Service Provider • Entrepreneur Service Provider
Service Provider
• Low Risk Distributor• Normal Distributor
Distributor
74
MANUFACTURERS
74
Typical manufacturing models
75
ParametersFull Fledge Manufacturer
Licensed Manufacturer Contract Manufacturer Toll Manufacturer
Produces on Own behalf Own behalf Principal Principal
Intellectual Property Owns the IP Licensed IP Does not own Does not own
Materials Owns Owns Owns Does not own
Rawmaterials
Principal
Contractmanufacturer
ProductionSchedule
FinishedGoods
ProductionSchedule
Principal
Tollmanufacturer
Raw materials FinishedGoods
Physical Flow
Legal Ownership
Information Flow
Functional Analysis - Functions and risks
76
Risk Meter
Product liability risk
Inventory risk
Market , Price, capacity,
warranty risk
Technology,R&D Risk
Manufacturing
Toll Manufacturer
Manufacturing
Inventory
Contract Manufacturer
Manufacturing
Inventory
Sales
Licensed Manufacturer
Manufacturing
Inventory
Sales
Intangible
Full Fledged Manufacturer
Assets
Plant, Work force
Warehouse, Inventory
Customer contracts/
relationships
Product licenses, process
intangibles
Functional Analysis - Characterisation
77
Profit
Loss
Intensity of functions and risks
1
2
3
4
1. Full fledged manufacturer
2. Licensed Manufacturer
3. Limited risk contract manufacturer
4. Toll Manufacturer
CASE STUDY 10
78
Suppliers XYZ UK
ABC India Suppliers
Outside India
Purchase of components
India
Sale of finished Goods
Customers
Purchase of components
Sale of finished Goods
What is the characterisation of XYZ UK and ABC India?
CASE STUDY 11
79
Suppliers
PrincipalManufacturer
Customers
Raw materials and semi finished goods
Payment for raw materials and semi finished goods
Finished goods
Payment for finished goods
Royalty payment on sales to 3rd party customers
License of manufacturing IP
What is the characterisation of the manufacturer?
CASE STUDY 12
80
Suppliers
Manufacturing PrincipalManufacturer
Customers
Raw materials and semi finished goods
Payment for raw materials and semi finished goods
Finished goods
Payment for finished goods
Finished goods
Manufacturing compensation (markup on manufacturing costs)
What is the characterisation of the manufacturer?
81
DISTRIBUTORS
81
Selling and marketing – Business Models
82
Marketing services company
Commission Agent
Commissionaire
Limited risk distributor
Loca
l fu
nct
ion
s, a
sse
ts &
ris
ks
Rewards/ Profits
Selling & Marketing
Normal distributor
Entrepreneur
Do not take title togoods
Take title togoods
Limited Risk Distributor (‘LRD’)
83
FAR Profile
• Limited marketing functions undertaken on behalf of principal
• A&M expenses incurred on account of principal
• A&M spend not significant
• Limited debtors/inventory functions/risks
• Does not bear start up losses
• Entitled to stable returns
Approach
• Key people functions performed by principal
• Distributor merely executes strategy formulated by principal
• Arm’s length ROS ensures A&M expenses incurred by distributor are “picked up” by principal
• TNMM applied with distributor as tested party
Limited Risk Distributor (‘LRD’)
84
Principal
• Responsible for product R&D and manufacturing functions
• Retains all distribution strategies
• Requires LRD to implement marketing/ sales promotion strategies & reimburses costs
• Takes debtors/ inventory functions/ risks
• Creates & owns marketing intangibles in selling country
• Bears start up losses in distribution
• Enjoys future super normal profits
LRD
• Marketing functions, if any, on behalf of principal against reimbursement of costs, generally with mark-up
• No debtors/ inventory risks - Debtors/ inventory pass through in books
• Entitled to routine/ steady returns
• Does not bear start up losses
Sale of finished goods
• Earns residual profit
• TNMM applied taking LRD as tested party
• Earns Low ROS
Principal
LRD
Normal Distributor (‘ND’)
85
FAR Profile
• Performs normal marketing functions
• A&M expenses within industry limits
• Undertakes debtors/inventory functions/risks
• Creates marketing intangibles e.g. customers list, dealer network etc.
• Gets assured gross margin
• Can suffer start up losses, entitled to future higher profits
Approach
• Distributor’s gross margin to be benchmarked using Resale Price Method (RPM)
• Intensity of functions critical while selecting comparables
• Return on VAE
Normal Distributor (‘ND’)
86
Principal
• Responsible for product R&D and manufacturing functions
• Retains limited / nil control on selling activities
• Does not take debtors/ inventory functions/ risks
• Own marketing intangibles such as brand name and trademarks
• Enjoys profits related to trade intangibles (e.g. technology, patent, brand name, trademarks)
• Does not enjoy super selling profits
ND
• Normal buy-sell distributor
• Carries out marketing/ sales promotion functions on own account, spend on marketing within industry standards/ limits
• Takes debtors/ inventory functions/ risks
• Stocks inventory
• Creates marketing intangibles in form of customer list/ dealer network, etc.
• Can suffer start up losses; also enjoys future super normal selling profits
Sale of finished goods
• Generally, RPM applied taking ND as tested party• Earns higher gross profit margin • If TNMM applied, earns High ROS
India
O/s India
Principal
ND
• Earns residual profit
Commission agent and Commissionaire
87
Commission
Customer
Commission
Customer payment
Sales contractCustomer payment
Principal Commissionaire
Title to goods
Principal
Contract; Trade invoice
Customer payment
Commission agent
Customer
Title to goods
Relationship between Principal and Commissionaire
• Customer does not need to know who “product” supplier is
• Commissionaire contracts in own name, but on behalf of the Principal and does not bind the Principal
• Invoice to customer in commissionaire’s name
• Commissionaire does not take title to inventory
• Commissionaire does not need to refer back to the Principal for acceptance within pricing and T&C parameters
• Commissionaire receives payment for goods and earns commission from Principal
Relationship between Principal and Commission Agent
• Commission agent identifies potential customers for the Principal, earning an arm’s length commission
• Customer knows who “product” supplier is
• Customer contracts with Principal
• Commission agent typically has no powers to conclude contracts on behalf of the Principal
CASE STUDY 13
88
Q: ABC is soliciting customers on behalf of its AE It is remunerated on a commission basis by its AE. The commission paid to ABC is certain percentage of the sale price of the machine sold by AE to third party in India. The AE raises the invoice.
What is the characterisation of ABC India??
A) Commissionaire
B) Commission Agent
C) None of the above
CASE STUDY 14
89
XYZ India Pvt Ltd (‘XYZ India’) and PQR India Ltd (‘PQR India’) are group companies.
XYZ India have marketing expertise in cancer products where as PQR India has marketing expertise in eye care products.
• XYZ India owns IP for eye care product say ‘Fresh Drops’
• XYZ India avails services from PQR India for marketing and promoting product ‘Fresh Drops’ in India
• PQR India is responsible for developing marketing strategy, budgets, promotion material, on behalf of XYZ India
• PQR India owns IP for cancer product say ‘Kill Cancer’
• PQR India avails services from XYZ India for marketing and selling product ‘Kill Cancer’ in India
• PQR India develops strategy for penetrating in the market. Therefore, it would be responsible for strategic decision making for its product
• XYZ India executes strategy for marketing & selling the product ‘Kill Cancer’
Case I Case II
Characterization of PQR India?? Characterization of XYZ India??
90
SERVICE PROVIDERS
90
Captive service provider
91
FAR Profile
• Provides services under the directions and specifications of the Principal
• Responsible for quality to a limited extent
• Responsible for manpower employed
• Does not undertake key decision marking activities
• Does not undertake any marketing function
• Does not assume any service liability, bad debts, foreign exchange or capacity utilization risks
Approach
• TNMM to be considered as the most appropriate method
• Remunerated on a total cost plus an arm’s length return
Example – BPO/ KPO set up by an overseas Multinational for carrying out certain outsourced activities.
Entrepreneur service provider
92
FAR Profile
• Performs services on its own account
• Performs significant people functions – i.e. responsible for all strategies and decision marking
• Responsible for the overall quality of service rendered
• Performs the marketing functions
• Assumes bad debts, service liability , foreign exchange and credit risks
Approach
• Being the most complex entity in value chain, it is entitled to residual returns
• Test the least complex entity and remunerate it basis the functions performed
Example – An Engineering company providing services to Indian customer. May avail certain design and engineering services from an overseas AE.
CASE STUDY 15• ABC Inc is an electronic component manufacturer based in Sweden and has a subsidiary in India, ABC
India
• ABC India as a manufacturer has the following transactions with its parent company:
• It sources components from ABC Inc to use in manufacture of CD players
• It imports CD players from ABC Inc for resale
• It receives technical know-how from ABC Inc and also uses the ABC brand name owned and developed by ABC Inc
• It avails foreign currency loan from ABC Inc
• ABC India also sources components for its manufacturing function from unrelated entities
• ABC India purchases CD players from unrelated entities for resale purposes
• ABC India sells CD players to its group company in Thailand and also to unrelated entities
Evaluate and discuss the approach to TP analysis for ABC Group.
93
ABC Inc.
ABC India
ABC Thailand
Outside India
India
Third Party Supplier
Customer/Distributor
100%
100%
• Import of Finished Goods
• Import of Components
• Use of brand name and receives technical know-how
• Availing of loan
Export
Sources components and finished goods
94
PART 4
95
BEPS Case Study
OECD BEPS action itemsOverview
Action 2: Hybrid mismatch
arrangements
Action 3:CFC rules
Action 4:Interest deduction
Action 5:Harmful tax practices
Action 6: Preventing tax treaty abuse
Action 7:Avoidance of PE status
Action 8:TP aspects of intangibles
Action 9:TP-risk and capital
Action 11: Methodologies and data
analysis
Action 12:Disclosure rules
Action 13:TP documentation
Action 14:Dispute resolutions
Action 10:High risk transactions
Coherence Substance Transparency
Action 1: Digital economy
Action 15: Multilateral instrument
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Analytical framework for intangibles
• Identify the legal owner: Based on the terms andconditions of legal arrangements, relevantregistrations, license agreements, other relevantcontracts.
• Identify the parties performing functions: Assetsused, and Risks Assumed relating to DEMPEFunctions of the intangibles
• Confirm consistency between conduct of the partiesand terms of the relevant legal arrangementsthrough a functional analysis.
• Identify the controlled transactions related to theDEMPE of intangibles in light of the legal ownershipof the intangibles and the conduct of the parties andverifying creation of value.
• Re-characterize/ Delineate transactions asnecessary to reflect arm’s length conditions
• Determine arm’s length prices for these transactionsconsistent with each party’s contributions offunctions performed, assets used, and risks assumed.
1. Identify legal owner
2. Identify parties regarding Functions,
Risks, Assets
3. Confirm consistency
4. Identify controlled transaction
5. Re-characterize transaction
6. Determine arm‘s length pricing
Steps in determining returnsKey functions
Development
Enhancement
Maintenance
Protection
Exploitation
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Return for legal
ownership of IP
Risk adjusted return on funding
Residual Return
TOTAL SYSTEM PROFITS
Entitlement of returns from exploitation of IP
• Registration / filings for the IP • IP administration, handling paper work etc.• Incurring legal fees for protection against
infringement etc
• Access to capital markets/ financial institutions• Providing funding for the R&D activity• Perform strategic and risk control functions relating to funding*• Has financial ability to bear risk related to funding
* Funder that does not control financial risk should be entitled to no more than a risk-free financial return
• Economic owner of IP• Performs DEMPE functions• Undertakes risk control functions and has financial
ability to bear risk
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Risk analysis
9999
Accurately delineated transaction should be compensated at ALP; appropriate pricing for risk management functions
If there is disparity, specific guidance to be applied on risk allocation
Determine whether the contractual assumption of risk is consistent with actual conduct
Evaluate conduct of parties (control functions and financial capacity to assume the risk)
Determine contractual risk allocation
Identify economically significant risks with specificity
Circular 6 of 2013The CBDT has carefully considered the matter and lays down the following guidelines for identifying the Development Centre as a contract R&D service provider with insignificant risk.
1. Foreign principal performs most of the economically significant functions involved in research or product development cycle either through its own employees or through its associated enterprises while the Indian Development Centre carries out the work assigned to it by the foreign principal. Economically significant functions would include critical functions such as conceptualization and design of the product and providing the strategic direction and framework;2. The foreign principal or its associated enterprise(s) provides funds/capital and other economically significant assets including intangibles for research or product development. The foreign principal or its associated enterprise(s) also provides a remuneration to the Indian Development Centre for the work carried out by the latter;3. The Indian Development Centre works under the direct supervision of the foreign principal or its associated enterprise which has not only the capability to control or supervise but also actually controls or supervises research or product development through its strategic decisions to perform core functions as well as monitor activities on regular basis;4. The Indian Development Centre does not assume or has no economically significant realized risks. If a contract shows that theforeign principal is obligated to control the risk but the conduct shows that the Indian Development Centre is doing so, then the contractual terms are not the final determinant of actual activities;5. In the case of a foreign principal being located in a country/territory widely perceived as a low or no tax jurisdiction, it will be presumed that the foreign principal is not controlling the risk. However, the Indian Development Centre may rebut this presumption to the satisfaction of the revenue authorities. Low tax jurisdiction shall mean any country or territory notified in this behalf under section 94A of the Act or any other country or territory that may be notified for the purpose of Chapter X of the Act;6. Indian Development Centre has no ownership right (legal or economic) on the outcome of the research which vests with the foreign principal and that this is evident from the contract as well as from the conduct of the parties.
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CASE STUDY – 16 (Typical supply chain for R&D COMPANY)pre & Post BEPS implications
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Typical supply chain (Pre-BEPS arrangement)
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IP owner and parent company relationshipa) IP owner has an exclusive right over the IP rights
outside of parent company’s jurisdiction.b) The entrepreneurial profit associated with the IP
rights accrues to the IP owner.c) While there is some substance in the IP owner,
strategic decision making with regards to theworldwide rights remains in the parent company.
IP owner and local / off-shore distributor relationship• IP owner licenses IP to a local distributor who
makes sales to third parties in the localjurisdiction (earns return on sales and paysresidual return to IP owner)
IP owner and affiliates relationship• IP owner enters into agreements with affiliates to
provide R&D and other services applicable to the IP. (possibly for a remuneration of cost plus mark-up basis)
Parent
IP Co/ “cashbox
” CoOffshoresubsidiary
Distributor
Infusion of funds
• Legal owner of IP
• Funds R&D activity
• Houses key R&D personnel/ management
IP license
Residual” license fee payment
Home country
Offshore
Affiliate/
R&D services Co
Cost plus mark-up for provision of R&D services
Appropriate Return on funding
• HQ functions• Access to capital
market
Pro
visi
on
of
R&
D s
erv
ice
s
• Local marketing efforts
Illustrative workingParticulars Pre BEPS Under BEPS
Total revenue from earned from distributor company 1,000
Third party costs incurred by distributors 100
License fee paid to/ received by IP Co 850(bal.fig)
Arm’s length Profit/ loss of Distributor Company 50[1000*5%]
Arm’s length remuneration paid by IP Co to R&D Co for services provided
230[cost plus 15%]
Third party costs incurred by R&D Services Co. 200
Arm’s length Profit/ loss of R&D services Co. 30
Amount paid by IP Co to HQ for capital and other management services
0
Third party cost incurred by IP Co 80
Arm’s length profit of IP Co 540[850-230-80]
Post BEPS implications
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• Function of funding and assuming and controlling related financial risks - shall be entitled to a risk-adjusted return on its funding. Also entitled to a return for the HQ and management functions.
Parent Co.
• Legal ownership of intangibles - May be entitled to routine return for IP ownership (administrative return).
IP Co
• Houses R&D personnel and potentially performs “DEMPE” functions
• AE assuming risks must exercise functional control over the risks and have the financial capacity to assume the risks. In this case, IP Co does not have relevant people function.
• May be entitled for a more than routine return of cost plus “mark-up”. Potentially, entitled to residual return (by using profit split) depending on extent of contribution.
R&D Service Company
• Whether it performs any activities towards enhancement of marketing intangible (over and above promotion and distribution activities)?
• Depending on the facts, profit split method may be considered to better reflect value contribution rather than TNMM or the resale minus method
Distributor company
Illustrative workingParticulars Pre BEPS Under BEPS
Total revenue from earned from distributor company 1,000 1,000
Third party costs incurred by distributors 100 100
License fee paid to/ received by IP Co 850(bal.fig)
800(bal.fig)
Arm’s length Profit/ loss of Distributor Company 50[1000*5%]
100[1000*10%]*
Arm’s length remuneration paid by IP Co to R&D Co for services provided
230[cost plus 15%]
400[Profit share]**
Third party costs incurred by R&D Services Co. 200 200
Arm’s length Profit/ loss of R&D services Co. 30 200
Amount paid by IP Co to HQ for capital and other management services
0 310[800-400-80-10]
[Residual return for HQ func/ risk]
Third party cost incurred by IP Co 80 80
Arm’s length profit of IP Co 540[850-230-80]
10(cost plus ~10%)
* Higher compensation considering that Distributor company contributes towards enhancement of marketing intangible** Simplified working
Australian Taxation Office (‘ATO’) issues Guidance addressing COVID-19 economic impacts on TParrangements, aims to “assist those economically affected by COVID-19 when preparing documentation tosupport the arm’s length nature of their transfer pricing arrangements”
1. Some businesses will be negatively affected by COVID-19, which may lead to a reduction in revenues,increased expenses, and changes to profit outcomes
2. Understand the facts and the individual circumstances by assessing:
a) the FAR profile of the Australian entity before and after COVID-19
b) economic circumstances, where the actual economic impacts of COVID-19 on the Australian operationsshould be outlined and evidenced – this may include a broader analysis of how the relevant industry hasbeen affected
c) the contractual arrangements between the Australian entity and its related parties, and if anyobligations or material terms and conditions have been varied, amended or terminated
d) evidence of the impact (if any) of COVID-19 on the specific product and service offerings of theAustralian entity and how this has affected the financial results
e) evidence of changes in business strategies as a result of COVID-19, including decisions made, outcomessort and actions taken to give effect to those strategies this was not a case where the assessee could besaid to have deliberately avoided making payment of tax so as to attract penalty u/s 271C
COVID-19 Impact
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Australian Taxation Office (‘ATO’) issues Guidance addressing COVID-19 economic impacts on TParrangements, aims to “assist those economically affected by COVID-19 when preparing documentation tosupport the arm’s length nature of their transfer pricing arrangements”
Understand the financial outcomes you would have achieved ‘but for’ the impact of COVID-19. This analysismay include:
a) a detailed profit and loss analysis showing changes in revenue and expenses, with an explanation forvariances resulting from COVID-19 – this may include a variance analysis of budgeted (pre-COVID) versusactual results
b) details of profitability adjusted to where your outcome would have been if COVID-19 had not occurred –this should consider all factors that have a positive or negative impact on your profits and should besupported by evidence
c) the rationale and evidence for any increased allocation of costs or a reduction of sales (and subsequentchanges in operating margins) to the Australian entity, taking into consideration its function, asset and riskprofile
d) evidence of any government assistance provided or affecting the Australian operations.
COVID-19 Impact
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Transfer Pricing impact areas on account of Covid-19 disruption
• “Cash is king” – Likely spike in intra-group financing transactions to overcome liquidity constrains
• Principles laid down in OECD Transfer Pricing Guidance issued in February 2020 on financial transactions
• Evaluate over-hauling/ restructuring overall TP model in light of the “new normal”
• Revise inter-company agreement to factor and address the challenges arising from the Pandemic
• Potential approach to economic analysis
• Stricter industry and comparability analysis to factor the sensitivity
• Identify and segregate extraordinary cost/ idle capacity cost/ additional cost due to supply chain restrictions/ extraordinary forex fluctuation etc.
• Use of internal comparable
• Consider entering into APA or renegotiate existing APA
• Limited use of traditional methods that use historical data
• Taxpayers should evaluate use of Profit Split Method – move away from one-sided method
• Guidance or clarification from CBDT would be welcome
• Potential use of most recent quarterly/ half year results?
• Rationalise safe harbour rules with reduced margins
• Guidance on identification of extraordinary/ Covid19 related costs
Questions and Answers
Thank you!
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